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Posted on July 22, 2012

It’s no secret that the states are in as much budget trouble as the federal government. Doubters should read a new report from a group headed by former Federal Reserve chairman Paul Volcker and former New York Lt. Gov. Richard Ravitch. By this account, states face four insistent forces: pension underfunding of at least $1 trillion; rapidly rising Medicaid spending; possible cuts in federal aid that provides $1 in $3 of state spending; and weak growth of tax revenue that, in 2011, remained 7 percent below its pre-recession peak.

What looms are higher state taxes and reduced services, affecting schools, police, parks, prisons, public universities, roads and social services. Up to a point, cuts may not do much damage; every government has waste. But we are rapidly passing this point.

Can we do anything? Well, yes. We could nationalize Medicaid — the federal-state health insurance program for the poor. We could transfer all its costs to the federal government; in exchange, the federal government would end state aid for K-12 education and transportation. Though initially a dollar-for-dollar swap, the change would give states more control over their budgets.

Created by Congress in 1965, Medicaid is hijacking state politics. Although the federal government covers a majority of costs (typically, 57 percent), the rapid rise in the states’ share compels cuts in other programs or steeper taxes. In the past decade, Medicaid spending has increased at nearly twice the rate of states’ tax revenue, notes the Volcker-Ravitch report.

The pressures will only intensify as America ages. Although Medicaid serves primarily a younger population (half are children), two-thirds of its costs stem from the 25 percent of much sicker beneficiaries who are elderly and disabled, reports the Kaiser Family Foundation. An older America will raise these costs and squeeze states’ other services.

This makes no sense. It expands the bias — already entrenched at the federal level — to favor the old over the young, the past over the future. And it underlines the need to control health spending, which increasingly is the crux of the national and state budget problems. In 2011, health spending represented 27 percent of the federal budget, up from 14 percent in 1990. For states, Medicaid spending was 24 percent of spending if all state funds, including federal grants, are counted, and 17 percent if only funds from state taxes are measured.

The Obama administration’s effort to expand Medicaid has further focused attention on states’ fears. Under the Affordable Care Act, Medicaid coverage would be extended to an estimated 17 million Americans. But the Supreme Court ruled that states can’t be forced to join. Some states — headed so far by Republican governors — have indicated they won’t, fearing the added costs. Although the federal government will initially cover those costs, it’s reasonable to worry that some future deficit-reduction package might shift more spending to states.

That’s one reason it makes sense to nationalize Medicaid. The idea dates back to at least the early 1980s, when then-Tennessee governor (now senator) Lamar Alexander proposed a “grand swap”: The federal government would assume responsibility for Medicaid and states would surrender federal aid to K-12 schools. Slightly modified, the switch still works. In 2012, states will spend about $200 billion on Medicaid. Against that, federal aid to states for schools and training totals $105 billion and construction grants (mostly for highways and transit systems) amount to $96 billion, says the Volcker-Ravitch report.

Spending and political accountability ought to be aligned. Only the federal government can devise a solution to control health costs; concentrating government health spending at the federal level would intensify pressures to do so. (States have tried mightily to control spending with at best partial success. For example, Medicaid reimbursement rates average only 72 percent of Medicare levels. The low rates have caused some doctors not to accept Medicaid patients.)

By contrast, federal school aid is only about 10 percent of the total; it mainly gives federal officials leverage to meddle in local affairs with little gain in student achievement. The same logic applies to transportation. We already have the Interstate Highway System. The benefits of better roads, transit systems or more bike paths are enjoyed mostly at the state and local levels, which is where the costs — how much to spend and on what — should be decided.

By itself, resurrecting Alexander’s grand swap wouldn’t solve states’ budget squeeze. Remember those underfunded pensions and slow-growing taxes. But it would help. This is one of those pragmatic proposals that ought to unite liberals and conservatives. Unfortunately, history suggests pessimism. President Ronald Reagan actually proposed a swap in 1982. It went nowhere, no doubt because it threatened the power of congressional committees and interest groups. Then as now, the status quo had a stranglehold on the future.